A Financial Independence Journey

What To Expect From Your Financial Baby

What To Expect From Your Financial Baby

Do you know what to expect from your financial baby? Do the returns from your investment portfolio leave you baffled? In this post, I will try to help you make sense of what to expect when you are expecting great things.

When I hear anyone talking about financial matters, my ears perk up and I tune in. I can’t help it. I heart personal finance.

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Recently I heard someone talking about how their “portfolio’ was not performing well and they wanted to sell that underperforming mutual fund and buy a better investment. In my head, I was thinking, how do you know it is performing badly? Is it because the account has not grown in dollar value or is it because you know that your investment is underperforming the market?

Expecting Too Much

This reminds me of a story my stepfather told me years ago. He and his brother were a mischievous pair in their preteen years. One day their neighbor pulled in his driveway with a brand new VW Bug and promptly came over to boast about his new “investment”.

At the time, in the mid-1970s, Americans were feeling the pain at the gas pump due to rising oil prices like never before. Their neighbor was so proud of the gas mileage his new VW bug was able to achieve. He kept a detailed log of how good his gas mileage was. Every week his gas mileage would improve, ever so slightly. And every week, the neighbor would boast about how he couldn’t believe that his gas mileage kept getting better and better as he continued to “break in” the engine in his new car. Little did he know my stepfather was adding small amounts of gas to his fuel tank causing abnormally high mile per gallon results.

Eventually my stepfather, for whatever reason, stopped adding fuel to the neighbors gas tank and the gas mileage plummeted. The neighbor came over to complain that he couldn’t figure out what had happened. He took his vehicle to the local mechanic who looked the car over and could not find any problems.

The story goes that, out of pure frustration the neighbor sold the car because he could never get back to the artificially inflated gas mileage that he was getting when my stepfather was adding gas to the tank.

What does this have to do with investing?

Well, the neighbor needed only to look at a benchmark to realize something was amiss. What was the average gas mileage supposed to be for his vehicle?

What do people expect from investments in the stock market? The truth is, for the average person, I don’t think people know what to expect. If your 401k is down 10% for the year, do you know how to see if this is good or bad?

Take a look at this post I pulled off of a social media thread. This screenshot was taken at the beginning of May. At that time, the S&P 500 was flat or slightly negative for the year. It comes as no surprise, the author of this post was seeing their balance stagnate or decline. He or She was looking to the personal finance world for help.

From my anecdotal experience, people just hope their account balance grows over time. It is not until that account balance stagnates or declines that people start to question whether their financial assets are in trouble.

A portfolio decline is not always bad

On the surface, a 10% decline in your 401k sounds awful right? You might be inclined to be upset, especially if you are paying a “financial guy” to get you good returns on your investment. But what if you had a negative 10% return and the stock market declined 20% in that same time period. Now your negative 10% returns don’t look so bad.

The Bogey

In golf, the term bogey means 1 stroke over par. In the investment world, a bogey is a term used to describe a benchmark against which returns and other characteristics of an investment can be made.

The bogey is the S&P 500 index

Simply put, the S&P 500 is the benchmark I use to compare all my investment returns against. If I buy any investment, I expect to at least meet or exceed the S&P 500.

What is the S & P 500

The Standard and Poor’s 500 has a long history. The index began in 1923 tracking only a few stocks. In 1926 the index expanded to 90 stocks. In 1957 the index grew into what it is today, tracking the 500 largest companies in America.

The S & P 500 is one of the most commonly followed stock indexes and you will hear the daily results reported on the nightly news or radio.

The largest 500 companies in America represent the lions share of the stock market. You can use the S & P 500 as a measurement tool to compare to your own investment returns. In other words, it is a good tool for measuring whether you are beating or underperforming the stock market as a whole.

What to expect from their financial baby

For most people, their 401k and or IRA represent their largest stock or mutual fund holdings. It is their “financial baby”. Now, knowing that the bogey is the S&P 500. Open up your 401k account statement or your IRA account statement. Compare your year to date results against the S&P 500 year to date results.

I can tell you that as of the closing bell on Friday, May 18th, 2018. The S & P 500 is up 1.5% year to date.

Using the S &P 500 year to date return(1.5%) as a measurement tool, your returns in your retirement accounts should also be close to 1.5%. If the returns in your account are wildly lower you should probably question why? Are you in an underperforming investment? Did you pay a large commision to acquire that investment? Are fees eating away at your return? These are real questions that need to be answered if you are underperforming the market.

The brilliance of matching the index

John Bogle, the founder of Vanguard, started the first index fund in 1976. The First Index Investment Trust was later renamed Vanguard S & P 500 index. He was berated for this idea of matching market returns. The common question of the time was, “why would people want average returns?” The truth was that 85% of actively managed mutual funds in the mid-1970’s were underperforming the S&P 500. Mr. Bogle hypothesized he could outperform the average mutual fund by 1.5% by reducing the costs associated with trying to outperform the stock market.

First Index Investment Trust began operations on August 31, 1976. From that modest base its assets would grow at a remarkably steady annual compound rate of 53% during the next two decades, taking assets to $42 billion on June 30, 1997. – Vanguard.com

Today, this approach, started by John Bogle, of matching market returns, has been copied by every major investment company in America.

Imitation is the sincerest form of flattery.

Conclusion

The next time you are wondering if your investment portfolio is letting you down. The first question you need to answer is, “how do my results compare to the S&P 500?” Am I underperforming the stock market (S&P 500) or am I just underperforming my expectations? Using a benchmark index like the S&P 500 will give you the answer you need to make an informed decision.

I hope you enjoyed this post. If you found it useful please leave me a comment. Let me know what you think.

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8 thoughts on “What To Expect From Your Financial Baby”

I loved the story about your stepfather and adding extra gas to his neighbor’s VW! For the longest time I was invested in a bunch of different non-index mutual funds. They obviously went up over time, but I really didn’t know how they were doing as a whole compared to the rest of the market (let alone all the fees they were charging). I’ve recently moved a majority of our investments into low cost index funds. I’ve stopped worrying about how our investments are doing, because I know for the most part they will track the markets. It makes things so much easier to manage. And I don’t have to overthink where to put our money!

Life does not have to be as complicated as people make it. Low-cost index funds are one of those ways that you will not only save money but make your life easier. As you said you also don’t have to constantly wonder if your financial person is doing a good job. Thanks for the comment, DGUY

That is a hilarious prank your stepfather pulled on the neighbor. I can only imagine the frustration it caused when he stopped adding gas. Did he ever come clean?

I wish I knew about index funds when I first started investing. It was only in my early 40’s did I stumble across the bogleheads and saw the light. Luckily the amount of money I had committed previously was relatively small so the mistake wasn’t as magnified as it could be.

If I know my stepfather, my guess is he did not ever fess up. You remember the name Janus funds. Yeah, I thought they would make me a millionaire. I poured every extra penny I had (which was not much) into those funds. I was naive when I was 20. I was chasing the crazy good returns. The dot-com bubble made me a convert to index funds. I still buy a few individual stocks but I really believe that boring index funds are near impossible to beat over the long run. Especially when figuring in ease of use and fees.

This is a great post and really good advice. I think this is a common issue and one that can be applied to a lot of different areas. I was recently helping a coworker choose funds for her retirement account and she had NO IDEA how much variability there can be in fees. A simple comparison can clear up a lot of confusion on just how good your investment is!

I’m glad you enjoyed the post. For so many people, the investing world is like speaking a foreign language. I wanted to really get across that you have to compare your returns against something. For me, that something is the S&P 500.